Government Grants Face The Axe!

Published on Tue, May 26,2015 | 23:41, Updated at Tue, May 26 at 23:41Source : Moneycontrol.com

By: Sunil Kapadia, Tax Partner, EY

ICDS-VII on treatment of Government grants provides for recognition of Government grants. It requires the taxpayer to reduce grants from the cost of depreciable asset or treat it as income over the periods necessary to match the related costs.

Prior to ICDS-VII, there was no specific provision under the Income-tax Act, 1961 (IT Act) for treatment of Government grants except for capital grants related to depreciable assets and certain specific revenue grants.

Apparently, realising that the cart has been put before the horse, the Government proposed an amendment in the Finance Bill 2015 to widen the scope of definition of ‘income’ to include assistance by way of grants. This assistance could be in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called). It encompasses assistance given by the Central Government or State Government or any authority or body or agency in cash or in kind. However, it excludes the subsidy or grant or reimbursement which is reduced from the actual cost of the depreciable asset under the existing provisions of IT Act.

To clarify the intent behind the proposed amendment, Ministry of Finance issued a Press Release on 5 May 2015 to state that the amendment was made to align the provisions of the IT Act with those in ICDS.

Prior to the amendment, Courts had correctly settled the law on the distinction between subsidy of a capital nature and that of a revenue nature. Hon’ble Supreme Court in the case of Sahney Steel & Pressworks Limited and Ponni Sugars & Chemicals Limited have principally (and rightly so) applied the ‘motive’ or ‘purpose’ test to determine the nature of subsidy. If the object of the subsidy scheme is to enable the tax payer to run the business more profitably or reimburse the costs incurred in running the business, then the subsidy would qualify as taxable revenue receipt. On the other hand, if the object of the assistance under the subsidy scheme is to enable the tax payer to set up a new unit or to expand the existing unit then the subsidy would qualify as capital receipt. Capital subsidies were held as not taxable – subject, however, to reduction from ‘actual cost’ of asset in case of depreciable assets.

Post the amendment proposed, most of the subsidies would become taxable as income with the exception of subsidies granted for purchase of depreciable assets which would need to be reduced from ‘actual cost’ of capital asset. The proposed amendment, therefore, would sort of overrule the principles laid down in the above Court rulings.

Although the proposed amendment is ostensibly to align with the ICDS provisions, it is not free from ambiguities. The proposed amendment talks about the assistance from Government or any authority or body or agency. Clarity would be required in respect of the grants received from non – government bodies, such as banks, financial institutions, parent/ holding companies.

Also, the proposed amendment does not amply clarify the year of taxability of assistance. Where taxpayer follows mercantile method of accounting, the subsidy will ordinarily be taxable in the year of accrual. However, ICDS provides that recognition of government grant shall not be postponed beyond the date of actual receipt.

Further, while the proposed amendment seeks to address the issue of taxability of grants, there is no corresponding amendment to permit a deduction from income, where such grants are required to be refunded to the Government due to non-fulfilment of compliance conditions. Appropriate clarity in this regard from the Government would be welcome.

The Government is propagating the policy of ‘Make in India’ which aims at, inter alia, generating local employment and developing backward areas. The incentives/ subsidies enable Government to attract investment into these areas and achieve uniform regional development. The Government partners with the entrepreneurs in sharing part of the pains of investing in backward areas through a capital contribution in the form of subsidies. By nature and objective, such subsidies are akin to capital contribution. With the amendment proposed, Government intends to treat such subsidies as revenue grant taxable as income. This would effectively mean that Government would first provide the assistance and thereafter, take back part of the assistance by taxing it. This may act as a dampener for investments in backward areas especially where small and medium enterprises (SMEs) are involved since such subsidies are key source of capital investment.

It would be worthwhile to recall that while considering the industry representations to provide tax deduction for CSR expenditure, the Government had promptly denied any tax benefit for such expenditure with an intention that the companies should use their own profits for CSR activities and not Government funds. With the proposed amendment the Government wishes to tax subsidies granted to taxpayers who partner with Government for the benefit of society at large.